Financial valuation of supply chain contracts

Abstract

This chapter focuses on a single buyer‐single supplier multiple period quantity flexibility contract in which the buyer has options to order additional quantities of goods in case of a higher than expected demand in addition to the committed purchases at the beginning of each period of the contract. It takes the buyer’s point of view and finds the maximum value of the contract for the buyer by analyzing the financial and real markets simultaneously. The chapter assumes both markets evolve as discrete scenario trees. Under the assumption that the demand of the item is perfectly positively correlated with the price of a risky security traded in the financial market, the chapter presents a model to find the buyer’s maximum acceptable price of the contract. Applying duality theory of linear programming, the chapter obtains a martingale expression for the value of the contract.